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November 23, 2015

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Page 2 November 23, 2015 • Law Times NEWS Securities law ruling Court pronounces on reasonable investigation defence BY JULIUS MELNITZER For Law Times egardless of the view people take on the efficacy of the leave test that plaintiffs must satisfy be- fore they can launch secondary- market securities class actions under the Ontario Securities Act, the recent deci- sion of Ontario Superior Court Justice Edward Belobaba in Rahimi v. South- Gobi Resources insinuates what some say is much-needed nuance into the courts' approach to leave applications. SouthGobi is also the first application in Ontario of the Supreme Court of Can- ada's judgment in Theratechnologies Inc. v. 121851 Canada Inc. in which the top court enunciated the need to undertake a "reasoned consideration" of the evidence in determining whether the plaintiff has a "reasonable possibility of success." At first blush, SouthGobi is a fairly common restatement case, falling into the category of lawsuits where plain- tiffs point to revenue restatements that acknowledge earlier errors said to have caused losses to numerous shareholders. But SouthGobi is a securities class ac- tion with a twist: The corporate and in- dividual defendants acknowledged the restatement but maintained that the ear- lier statements were true at the time and were therefore not misrepresentations. They attributed the changes, Belobaba noted, to "a change of judgment on the part of the company's auditors that man- agement and the board of directors were forced to accept because of other corpo- rate and financial pressures." The defendants also argued they had conducted a reasonable investigation at the relevant time and were therefore not liable. Belobaba allowed the action to pro- ceed against the company. While he rea- soned that a court could "readily agree" that there had been a diligent corporate review approved by two of the major ac- counting firms, the company's restate- ment was "explicit" in acknowledging the need for corrections and a "material weakness" in the organization's internal controls. "These are serious pronouncements that may be explained and rebutted on a balance of probabilities by the defen- dants at trial but on a leave motion they remain significant," wrote Belobaba. Belobaba, however, refused to grant leave against the individual defendants "on the basis of the reasonable investiga- tion defence." Defendants asserting that defence must show they conducted a reasonable investigation before the misrepresenta- tion became public and that they had no reasonable grounds to believe, at the time of the release, that the document contained the misrepresentation. While defendants will often raise the reasonable investigation defence at trial, the Ontario Court of Appeal has, in Green v. Canadian Imperial Bank of Commerce, approved its use on a leave application. But it's not easy for defen- dants to overcome the test established by Green. "It is not enough for the defendants to show reasonable investigation on a bal- ance of probabilities as suggested by the defendants," wrote Belobaba. "This is not the test on a leave motion. Rather, if there is a reasonable possibil- ity that the defendants will not be able to establish both elements of this defence at trial, the motion for leave must be granted." In this case, however, the five individ- ual defendants responding to the motion had met the burden and the case couldn't continue against them. "The court found that they did every- thing that they could reasonably have been expected to do as members of the audit committee, board, and manage- ment," says John Campion of Fasken Martineau DuMoulin LLP in Toronto. "The court also found [there] were no reasonable grounds to believe that the various financial disclosures released under their jurisdiction in the time pe- riods in question contained any misrep- resentations," says Campion, who rep- resented SouthGobi and five of the six individual defendants. As Campion points out, the court went to considerable lengths to reach those conclusions. "When the leave test was combined with the requirements of the reasonable investigation defence, the court was re- quired to consider the 'compelling and voluminous evidence of the defendants' under a high-powered microscope," he says. Campion's Montreal partner Pierre Lefebvre, who was lead counsel for the defendant in Theratechnologies, says the Supreme Court's decision laid the groundwork for SouthGobi. "Theratechnologies changes the entire dimensions of the leave test," he says. "It makes it clear that defendants can raise circumstances and facts to demon- strate the reasonable investigation de- fence." Campion is of similar mind. "This case is an excellent example of what is needed to meet the leave test by answering a claim on the basis of a de- fence to the action rather than an answer which argues that the action has no mer- it," he says. Still, as Michael Robb of Siskinds LLP points out, the lawsuit is hardly dead in the water. "Under the statutory regime, the vast majority of the economic value of the case lies in the allegations against the company, not the individuals, and that is certainly moving forward," says Robb, who's acting as counsel for the plaintiff in SouthGobi. 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